Junk Bond Spread Breakout

The famous dead parrot is coming back to life… in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” – mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while “investors” (we use the term loosely) pile into ridiculously overvalued bonds that will eventually saddle them with eye-watering losses.

 

The famous dead parrot

 

Readers may recall previous discussions of credit spreads in these pages –  on a whim we likened the demise of creditor suspicion to the dead Norwegian Blue in the Monty Python sketch. Credit is considered “suspicion asleep”, and the debate in the sketch revolves around whether the bird is merely sleeping or actually dead. Given what has occurred in credit spreads over the past two years, it is not too far-fetched to state that creditor suspicion appears to be dead rather than just asleep.

But we knew it would do the zombie thing and wake up again one day. We refer you to The Coming Resurrection of Polly and An Update on Polly for some background information. In the former we discussed inter alia how credit spreads have behaved in the past in the final stages of a boom and showed numerous charts illustrating what we believed to be quite important points; something traders and investors needed to file under “things to keep a close eye on”.

The points were a) the end comes very suddenly (and hence “unexpectedly”) every time and b) from a technical perspective, all it took on past occasions was a breakout in spreads above the nearest lateral resistance level. A small, barely noticeable breakout, followed by a successful retest – and suddenly spreads would take off into the blue yonder.

This is precisely what has just happened in euro-land, i.e., the global center of spread manipulation by a central planning agency. Behold a classic chart picture:

 

BofA/Merrill Lynch euro area high yield index spread (option-adjusted refers to the to the incorporation of early call options by issuers, which allow them to redeem bonds ahead of schedule). This is a picture-perfect breakout in junk bond spreads. Based on the  technical picture, this market is now a screaming short (n.b.: prices move inversely to yields).

 

Proceed with Caution Anyway

If you are pondering whether you should mortgage the farm, pimp grandma and sell your offspring into slavery to bolster your shorting wherewithal, hold your horses for a moment. As always there are caveats, despite the admittedly enticing technical imagery (coupled with the knowledge that corporate debt has been an accident waiting to happen for quite some time). We do see a potential opportunity here, but one should proceed with caution. Here is why.

Consider that the driving force behind the breakout was a political event, namely the recent election in Italy. We are of two minds about this trigger event. On the one hand, the effects of political news on market action are notorious for their fleeting nature. This is all the more relevant in euro-land, where the eurocracy has proved on numerous occasions that it is able to enforce its diktats, no matter how determined its opposition appears to be.

Just think back to the emasculation of  Syriza in Greece, or in the context of Italy, the palace coup that deposed the up until then untouchable Cavaliere, Uncle Silvio. Keep in mind that this was a man on whose behalf Italy’s legislature  passed laws that had no other purpose than to keep him out of legal trouble. And yet, it took the apparatchiks in Brussels very little effort to show him just who was actually the capo di tutti capi. Why would the Lega/5-Star coalition fare any better? As an aside, the Cavaliere is actually back in action these days, proving that he remains astonishingly resilient.

 

Comeback king Uncle Silvio, once upon a time unceremoniously deposed by Brussels, is back in the thick of things.

Photo credit: AFP

 

On the other hand, one could well argue that the trigger does not really matter and that it has simply pushed the market to a level that is more closely aligned with reality than the bizarre Potemkin village constructed by ECB intervention.

There is another caveat though: US high yield spreads have failed to mimic the action in Europe so far. No breakout over lateral resistance is in evidence. In fact, effective yields on the lowest-rated US junk bonds (CCC or lower) have recently declined even further – presumably because many of these were issued by energy companies, which are currently supported by fairly high crude oil prices. Yields on better-rated junk bonds have increased, but so have treasury yields. As a result there was no effect on spreads:

 

US high yield spreads (BofA-ML Master II Index) – no breakout is in sight yet, but obviously this needs to be watched closely now.

 

Conclusion

Given the circumstances and the lack of “contagion” one might want to wait for US junk bond spreads to follow suit before jumping on the new trend. Keep in mind though that euro-area spreads were a leading indicator on the way down and the same may turn out to be the case on the way up. In short, at the very least the breakout in European junk bond spreads constitutes a warning sign for risk assets – which happens to be in line with the sharp slowdown in money supply growth since late 2016.

 

Charts by: AM, data by St. Louis Fed / BofA-ML

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • A Surprise Move in Gold
      Traders and Analysts Caught Wrong-Footed Over the past week gold and gold stocks have been on a tear. It is probably fair to say that most market participants were surprised by this development. Although sentiment on gold was not extremely bearish and several observers expected a bounce, to our knowledge no-one expected this:   Gold stocks (HUI Index) and gold, daily. As noted in the annotation above, a Wells Fargo gold analyst turned bearish at the worst possible moment...
  • May Away
      May Gone in June... Yes, now that June is here, it is indeed the end of May. Theresa May, to be precise, the henceforth former British Prime Minister. After delivering her unparalleled masterclass in “how to completely botch Brexit”, British cartoonists are giving her a well-deserved send-off, which we are documenting below. But first, in case you don't know anything about Ms. May's heroic “Brexit”-related efforts, here is an explanation of how she tried to finagle the best...
  • Elizabeth Warren’s Plan to Bamboozle American Voters
      A Plan for Everything! The run-up to the presidential primaries offers a funhouse reflection of American life.  Presidential hopefuls, hacks, and has-beens turn to focus groups to discover what they think the American electorate wants. Then they distill it down to hollow bumper stickers. After that, they pump their fists and reflect it back with mindless repetition.   A plea for clemency from Mr. 1/1024th crow. [PT]   Change We Can Believe In.  Feel the...
  • Fed Chair Powell’s Plan to Pickle the Economy
      A Loose Relationship The Dow Jones Industrial Average made another concerted run at the elusive 27,000 milestone over the last several weeks.  But, as of this writing, the index has stalled out short of this psychosomatic barrier.  By our estimation, this is for the best.   Since early 2018 the DJIA has gone nowhere, albeit in interesting ways... [PT]   While not always apparent, the stock market generally maintains a loose connection to the underlying...
  • Paul Tudor Jones Likes Gold
      Gold is Paul Tudor Jones' Favorite Trade Over the Coming 12-24 Months In a recent Bloomberg interview, legendary trader and hedge fund manager Paul Tudor Jones was asked what areas of the markets currently offer the best opportunities in his opinion. His reply: “As a macro trader I think the best trade is going to be gold”. The relevant excerpt from the interview can be viewed below (in case the embedded video doesn't work for you, here is a link to the video on...
  • The Italian Job - Precious Metals Supply and Demand
      Lira Comeback? The price of gold jumped 35 bucks last week, and that of silver 48 cents. The dollar is now down to 23 milligrams of gold. Keith is on the road this week, so we will just comment on one thing. If Italy is serious about moving back to the lira, that will make the euro less sound (to say nothing of the lira). That will drive people mostly to the dollar, but also to gold.   Italian deputy prime minister Matteo Salvini (as the leader of the Lega party he is...
  • Bitcoin: What is the Best Day of the Week to Buy?
      Shifting Patterns In the last issue of Seasonal Insights I have discussed Bitcoin’s seasonal pattern in the course of a year. In this issue I will show an analysis of the returns of bitcoin on individual days of the week.   Bitcoin, daily – since bottoming in early December, BTC has advanced quite a bit. It remains an excellent trading sardine. [PT]   It seems to me that Bitcoin is particularly interesting for this type of study: it exhibits spectacular price...
  • Feeling the Heat of a Civilization on the Downside
      An Epic Folly for the Ages Today we begin with a list.  A partial list.  And in no particular order... Angela Merkel. Donald Tusk. Mario Draghi. Donald Trump. Jerome Powell.  Shinzo Abe.  Haruhiko Kuroda.  Theresa May. Boris Johnson. Mark Carney. Xi Jinping.  Emmanuel Macron.  Vladimir Putin. Justin Trudeau. Juan Trump.  And many, many more...   Politicians and bureaucrats of the modern age of statism and central planning... fighting a rearguard action...
  • Silver Remains a Monetary Metal - Precious Metals Supply and Demand
      Silver Price Driven by Reservation Demand The price of gold went up a buck last week, but the price of silver dropped back 13 cents. And the gold-silver ratio marches further upwards. Keith spoke at a conference this week, about how to analyze the fundamentals of supply and demand in gold and silver. He talked about the basis of course.   Silver coins – silver prices are partly influenced by an industrial demand component, but the fact that they move most of the time with...
  • “We’re All Socialists Now”
      An Ominous Sign of Things to Come Despite being probably robbed of the Democratic Party’s nomination by the Clinton political machine, the success of the Bernie Sanders’ 2016 campaign with his advocacy of “democratic socialism” was an ominous sign of things to come and, in some sense, more telling of the political climate than Donald Trump’s improbable victory in November, 2016.   Bernie Sanders, yet another professional finger-wagger (he is actually famous for his...
  • How Do Stock Prices React to Rate Cuts by the Fed?
      The “Greatest Economy in History” Stumbles “This is the greatest economy in the history of our country”, Donald Trump opined just a few months ago. Alas, recently there is growing evidence of an economic slowdown.   The Morgan Stanley MSBCI business conditions gauge plummets to its lowest level since 2008, as recent economic data releases ominously persist in disappointing. [PT]   This has fueled speculation of imminent rate cuts by the Fed. You may...

Support Acting Man

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!